E-piphany

Below is a summary of my post-CPI tweets. You can (and should!) follow me @inflation_guy. Or, sign up for email updates to my occasional articles here. Investors, issuers and risk managers with interests in this area be sure to stop by Enduring Investments!

• Nice, sunny morning for #CPI here in the Northeast. Get ready for some fireworks today! I honestly can’t remember a time when a wider range of potential prints was not only possible, but plausible.
• Last month, we saw a significant upside surprise as core inflation came in at +0.34% m/m. Yet, at some level this isn’t a surprise to those of us who are buying things.
• What was really interesting about last month is that some of the big movers we expected – most notable among them used cars – did nothing special (Used Cars rose 0.55% m/m, yawn).
• And yet, the upside surprise was also not in housing. Rents remained soft (more on that in a minute). So Median CPI, which we focus on more, was actually only +0.15% m/m.
• Think about that…what that means is that the inflation surprise last month was due to large moves in smaller components – ones that no one expected to jump. If that doesn’t describe what inflation feels like in the real world, I’m not sure what does.
• So turning to this month and the months ahead. We’re still waiting for rents (both primary rents and OER) to reflect the heat in the housing market and in the meteoric rise in asking rents.
• My premise is that the abrupt and unusual divergence here is caused largely by the CDC’s eviction moratorium from last August, which has been extended several times – but which was recently vacated by a judge as being an overreach by the CDC.

• I don’t know if that’s the last word, but in any case I wouldn’t expect that to have an effect THIS month. If we see a larger rise in rents, it’s organic from the general frothiness in housing and probably not from this effect, yet.
• Also, we’re watching for used cars to catch up to private surveys. That’s a huge effect. Used Cars is 2.75% of the CPI, and New Cars has also seen upward pressure (it’s another 3.75%). That could easily add 0.1%-0.2% to core this month by itself.

• There are lots of other places we may see pressure. There are shortages of containers, shipping, drivers, packaging, semiconductor chips, cotton, chlorine, ketchup, lumber, and the list goes on. Many of those categories are upstream to a LOT of consumer products.
• Moreover, let’s not forget that there is a shortage of labor in certain sectors of the service economy. We haven’t gotten the Atlanta Fed Wage Tracker this month, but Average Hourly Earnings showed a big jump. That also feeds into consumer prices.
• So economists this month are calling for 0.3% on core CPI, which thanks to base effects would move y/y to 2.3%. Given the usual CPI/PCE spread, that means we’d basically be at the Fed’s long-term target, FWIW.
• This is much better than last month’s guess from the economists’ models, but with used cars alone I think you ought to be looking for that much. There are forecasts out there for +0.4% and even a few at +0.5%. Big shops, not people looking for notoriety.
• That’s really not crazy at all. In fact while the Street consensus is 0.3%, the inflation derivatives market is closer to 0.4% as the NSA print traded yesterday several times around 265.9 (0.1% higher than the economists’ 265.6 guess).
• Last month, the interbank market was also 0.1% higher than the economists, and they were right. FWIW the inflation market feels long to me, but there’s a lot of slower money at play too so the usual hedge-fund-flush MAY not necessarily follow any disappointment.

• Regardless of what happens, the Fed will say transitory, and perhaps they are right. But either way, it’s economic volatility and that benefits no one (unless you’re long convexity). Not investors, and certainly not consumers. Good luck out there. 8min until #CPI.

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• Bug, meet windshield.
• Core CPI +0.92% m/m. Yes, you read that right. Waiting for someone to say misprint. 2.96% y/y.

• Incredibly this has nothing to do with rents. That’s amazing. A big move like that in core…hard for it not to involve rents. Primary Rents +0.20% m/m. OER +0.21% m/m. Ham-on-rye rent numbers as they say.
• But Used Cars were +10.0% m/m, which means that series basically caught up to the private surveys in a single month. The good news is that removes some of the dry powder for future months.

• These charts are comical. This is core goods (+4.4% y/y) and core services (a mere +2.5%).

• The last time Core Goods was as high as +4.4% y/y was in 1991.
• Airfares +10.2% m/m, which is part of that services jump. Lodging away from home +7.7%. Those are Covid/reopening categories.
• Apparel as a whole was +0.32% m/m. It’s a small category but I’d been wondering why it had been so tame given that there was an embargo on certain Chinese cottons – I would have thought we’d have seen more.
• In Medical, Pharmaceuticals were +0.63% m/m; Doctor’s Services ebbed a bit (-0.29% m/m) and Hospital Services was tame (+0.18% m/m).
• A lot of my tweets are proceeding slowly because I have to check the numbers. Plus all of the charts re-scaled. Core ex-shelter is +3.57% y/y. Hasn’t been over 2% since 2012. Not over 3% since 1995.
• OMG I buried the lede. Core CPI isn’t quite at 3%, though it rounded there. It hasn’t been ABOVE that since 1995. A quarter-century.

• Core ex-shelter.

• Sorry for the lag folks. My computers are literally throwing up on this data.
• Interestingly, CPI for New Cars was only +0.26% m/m. In New Cars, there’s simply a shortage brewing but sticker prices haven’t risen very much. I think that’s a “yet”. The shortage is due partly to the shortage of chips of course.
• OK, I am going to have to stop this here without a whole bunch of other stuff that is going to be great to look at…when my java/SQL connection decides to work. Here’s the bottom line though:
• Core inflation at +0.9% is so outrageous that ironically the Fed will have an easier time ignoring it for now. And there were some things that we expected to catch up over multiple months, that caught up all at once. BUT there are also some things yet to come. >>
• If primary and OER rents catch up merely to where they ought to be given historical relationships to asking rents, home prices, etc, then that’s another 1% or thereabouts on core CPI. And that’s harder to assume away than a used car spike. >>
• But what we know is that next month, we will have the first core CPI y/y above 3% in more than a quarter-century. Because we still have one more easy comp from May. But we always knew this would be hard to read – and the smoke won’t clear until late this year.
• Transitory? Better hope so. If not, look out below on stocks and bonds. That’s all for today. Thanks for tuning in and sorry I didn’t have more of my usual charts. If I get stuff working I may post them later.

Today’s month-over-month core CPI reading was the largest monthly figure since…wait for it…1981. That’s right, four decades ago. Yes, some of these things are going to be transitory. But they’re also going to be reprogramming consumers’ expectations. I’ve never been a big fan of the idea of anchored inflation expectations but as I wrote recently in “Once Again, You Ain’t Getting No Coke” whatever behavioral anchor there may have been is definitely threatened when there are large changes in prices.

Now let me add back a couple of the charts that I normally include, and maybe a couple of others. Here are the four-pieces charts. Each of these pieces is 1/5^th to 1/3^rd of the CPI consumption basket. There are lots of ways to cut the data but this is one I find useful. The first piece is Food & Energy. Little noticed in all of the craziness about core is that food and energy prices are also increasing markedly. Indeed, some food prices are rising as fast or faster than they did back when rising food prices helped spark the “Arab Spring.” Are we surprised at the unrest in Gaza? Get ready for more of that.

Second piece is core goods. Big piece of this is used cars. Kind of strange that new cars haven’t yet shown much of an uptick. The driver (no pun intended) of used cars is not just the huge tide of money of course, but also the smaller stock of used cars since rental fleets last year were shrunk a lot due to COVID. And rental car fleets are a big source of used cars.

Core services less rent-of-shelter is the third piece. Airfares, lots of personal services like child care, moving and storage, domestic services, etc. In a way, that’s a surprising piece here since this isn’t a raw materials gig, at least directly. But these services use packaging materials, cleaning materials, and other items whose prices are rising – and so are wages.

Finally, Rent of Shelter. The big bounce here is in Lodging-Away-from-Home, which was part of what was dragging it down. But rents themselves remain soft in the CPI, which I have to repeat is at odds with lots of the other ways we measure the cost of housing. This doesn’t mean that the CPI is ‘manipulated’; these discrepancies arise from time to time and we have a good reason to believe this is related to the eviction moratorium. I’m very confident rents will reconverge higher.

Now, because housing hasn’t lurched higher yet the median inflation figure will not be too bad. +0.3% m/m or so is what we’re likely to see, raising y/y to 2.17% or so. To be sure, +0.30% on median CPI is a big number for that series but not unprecedented. So today’s report is one reason that I always admonish people to look at median, not core. Core inflation is not going to rise at 11% this year. But remember the microwave-popcorn analogy: these one-off anecdotes are the way inflation is really experienced in practice. Maybe not 50% increases in used car prices, but a pop here and a pop there. This shows up as fatter tails on the high side of the distribution as opposed to the low side of the distribution when we are in a disinflationary environment. In an inflationary environment, we expect core inflation to be above median inflation because of those recurring “one-off” events. And, for the first time in a very long time, it is.

Finally, one more chart here and that’s of the EI Inflation Diffusion Index, which attempts to measure how widespread price increases are. It just peeked above zero for the first time since 2012. It keeps more distribution information than the median does, which is why it tends to rhyme with median but sometimes diverges.

Now let me sum up: the Fed doesn’t care. Oh, I am sure there are people at the Fed who will be alarmed, but the bottom-up people will see anecdotes and long-tails and not be worried. It’s the top-down people who are alarmed: the people who see money growth over 20% and have been bracing for what has historically always accompanied such money growth. But those people have no voice at the Fed. The main power around the table is concerned about making sure the unemployment rate is as near zero as possible. It’s an odd reversal from the Greenspan (and earlier) days, when the Fed believed that the way to maximize employment in the long run was to hold inflation low and steady. The Federal Reserve today behaves as if the best way to hold inflation low and steady in the long run is to maximize employment in the short run. That’s obvious nonsense, but here’s the important point: the crazy volatility of the economic data around COVID and in the base effects post-COVID create a fog of war that means it will be late 2021, and maybe even into 2022, before it will be clear to everyone that inflation is really settling down at a level higher than it was pre-COVID. Before then, the stock and bond markets are likely to discount worse price/rate conditions, which if anything will trigger even looser policy from the central bank.

In other words, by the time the Fed decides that cooling off price increases is more important than goosing the economy or the stock market, we will be very far down the road of squandering the Volcker Dividend. Behave accordingly.